The Health Savings Account or HSA is an underrated, quasi IRA/Roth IRA-type plan that can make paying almost all types of health-related expenses extremely tax efficient. This article will explain everything you need to know about the Self-Directed HSA.
What is an HSA?
An HSA is a tax-exempt trust or custodial account you set up with a qualified HSA trustee, such as IRA Financial, to pay or reimburse certain medical expenses you incur. An HSA can be invested in traditional equities, such as stocks or mutual funds, but also alternative assets, such as real estate or precious metals.
Who Can Set Up an HSA?
Anyone can set up a Self-Directed HSA, subject to certain eligibility requirements. To be an eligible individual and qualify for an HSA contribution, you must meet the following requirements:
- You are covered under a high deductible health plan (HDHP), on the first day of the month, and
- You are not enrolled in Medicare.
Note – you can’t be claimed as a dependent on someone else’s tax return
What is a High Deductible Health Plan (HDHP)?
In order to make contributions to an HSA, one must be enrolled in a or HDHP, which is defined as:
- A health plan with a higher annual deductible than typical health plans, and
- A health plan that has a maximum limit on the sum of the annual deductible and out-of-pocket medical expenses that you must pay for covered expenses.
How Much Can You Contribute to an HSA?
The maximum annual contribution to an HSA is determined by a few elements, including who you are covering (just yourself or a family), how old you are, and how long you’re covered by an eligible healthcare plan.
- The maximum contribution for self-only coverage is $4,150 for 2024.
- The maximum contribution for family coverage is $8,300 for 2024.
- Those age 55 and older can make an additional $1,000 catch-up contribution.
What are the Benefits of an HSA?
There are many tax and savings benefits to establishing and funding an HSA:
- You can claim a tax deduction for contributions you make to your HSA even if you don’t itemize your deductions on Schedule A (Form 1040).
- Contributions to your HSA made by your employer are not included in your gross income for tax purposes.
- The contributions remain in your account until you use them and grow without tax.
- Like a traditional IRA, the interest or other earnings on the assets in the account are tax free.
- Power of compounding returns – the income and gains from the HSA will grow faster than a regular savings account because they are not subject to income tax.
- Distributions from the HSA may be tax free if you pay qualified medical expenses.
- An HSA is “portable.” It stays with you if you change employers or leave the work force.
What are Qualified medical expenses?
In general, qualified expenses for HSA plan purposes include doctor visits, medications, medical equipment, and dental and vision care for you, your spouse and any dependents.
Qualified medical expenses are those expenses that would generally qualify for the medical and dental expenses deduction, such as physical therapy, vaccines, eyeglasses, and OTC medicines. Ineligible expenses include aromatherapy, baby wipes, lotion, and mouthwash.
Finally, there are dependent care expenses, such as babysitting, nursery school, and eldercare expenses. Ineligible in this vein include clothing, higher education expenses, and food/meals.
To read the updated list of qualified medical expenses, check out the IRS website.
Taxation of a Self-Directed HSA
In general, an HSA is generally exempt from tax. You are permitted to take a distribution from your HSA at any time; however, only distributions used exclusively to pay for qualified medical expenses are tax free. If you select a spouse as your HSA beneficiary, then upon your death, the HSA would pass to your surviving spouse without tax. If you select a non-spouse beneficiary for the HSA, the account stops being an HSA, and the fair market value of the plan becomes taxable to the beneficiary in the year in which you die.
Types of Self-Directed HSAs
As previously mentioned, an HSA can be invested in both traditional and alternative asset investments. Like the IRS prohibited transaction rules, an HSA cannot be invested in life insurance, collectibles and prohibited transactions under Internal Revenue Code Section 4975. Accordingly, an HSA must not be invested in any investment that will directly or indirectly personally benefit the HSA owner or any of his or her lineal descendants or any entity/trust controlled (50% or more) by such persons.
There are two ways one can invest an HSA into alternative assets:
Self-Directed HSA – Full-Service
With a full-service Self-Directed HSA, a special custodian/trustee, IRA Financial, will serve as the custodian of the HSA. The HSA funds are generally held with the custodian/trustee, and the owner would then direct IRA Financial to invest the HSA funds in IRS-approved investments, such as real estate. Title to the asset will be in the name of the custodian care of the HSA owner. For example: IRA Financial CFBO Lisa Smith HSA.
A Self-Directed HSA that is full-service is popular with retirement investors looking to invest in alternative assets which do not involve a high frequency of transactions and are long-term holds in nature, such as the purchase of raw land or private fund investments.
Self-Directed HSA – “Checkbook Control”
With a Self-Directed HSA with “checkbook control,” the plan is set up with a custodian that specializes in self-directed retirement plans, such as IRA Financial. The HSA is then invested into a special purpose limited liability company (LLC), which IRA Financial can help establish, and then managed by the HSA plan owner, providing him or her with checkbook control over the HSA funds. The owner would serve as the manager of the plan.
As per the LLC operating agreement, the HSA owner, as manager of the LLC will have the authority to make the investment decisions without the involvement of the custodian. Plus, a Self-Directed HSA LLC would offer the plan owner with limited liability protection over IRA investments. All investments will be titled in the name of the LLC providing a higher degree of privacy.
How to Record Keep your Self-Directed HSA?
The key aspect from a record keeping perspective when establishing any type of HSA is that the owner must keep records sufficient to show that:
- The HSA distributions were exclusively to pay or reimburse qualified medical expenses,
- The qualified medical expenses hadn’t been previously paid or reimbursed from another source, and
- The medical expenses hadn’t been taken as an itemized deduction in any year.
These records should not be attached to your income tax return. The HSA owner should just keep them with all their other tax records. When it comes to requesting an HSA distribution from your Self-Directed HSA, the custodian/trustee will send you the funds and it is the responsibility of the HSA owner to demonstrate that the distribution was for a qualified medical expense.
How to Report an HSA Distribution from a Self-Directed HSA?
If an HSA owner takes a distribution to pay for an expense, he or she is not subject to income tax on the distribution. However, the HSA owner must report the distribution on IRS Form 8889. You must file Form 8889 with your Form 1040, 1040-SR, or 1040-NR if you (or your spouse, if married filing jointly) had any activity in your HSA during the year. If you do not use a distribution for qualified medical expenses, you must pay tax on the distribution.
Employer HSA Contributions
It is not widely known that an employer with a HDHP may make HSA contribution on behalf of their employees. The employer would be permitted to receive a tax deduction for the HSA contributions made to the employees. Additionally, the employer would be required to make sure that all employee contributions are comparable taking into account either the contribution amount or percentage.
Conclusion
In conclusion, a Self-Directed Health Savings Account offers individuals greater control over their healthcare funds, allowing for more personalized investment decisions and long-term financial growth. By managing their HSA like a retirement account, individuals can maximize tax advantages, build savings for future medical expenses, and even enhance their overall financial strategy. However, it requires careful planning, understanding of investment options, and ongoing management to ensure it aligns with one’s health and financial goals. With the right approach, a Self-Directed HSA can be a powerful tool for both health care security and financial independence.
